Loans Receivable

Loans that management intends to hold until maturity or pay off and for which the Company has the ability to hold for the foreseeable future are reported at their outstanding principal balance adjusted for unearned income, charge-offs, the allowance for loan losses, any unamortized deferred fees or costs on originated loans, and unamortized premiums or discounts on purchased loans.

For loans recorded at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, as well as premiums and discounts, are deferred and amortized as a level yield adjustment over the respective term of the loan.

Categories of loans include:



	March 31, 2014			December 31, 2013
Real estate loans
Residential	$	192,733		$	191,007
Commercial	166,800			142,429
Total real estate loans	359,533			333,436
Commercial loans	63,373			55,168
Consumer loans	104,694			107,562
Total loans	527,600			496,166
Deferred loan origination costs and premiums and discounts on purchased loans	4,649			4,987
Allowance for loan losses	(5,388		)	(5,426		)
Loans receivable - net of allowance for loan losses	$	526,861		$	495,727

The risk characteristics of each loan portfolio segment are as follows:

Commercial Real Estate: These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of property type and geographic location. Management monitors and evaluates commercial real estate loans based on property financial performance, collateral value, and other risk grade criteria. As a general rule, the Company avoids financing special use projects or properties outside of its designated market areas unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate loans versus nonowner-occupied loans.

Commercial: Commercial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected, and the collateral securing these loans may fluctuate in value. Loans are made for working capital, equipment purchases, or other purposes. Most commercial loans are secured by the assets being financed and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis.

Residential and Consumer: With respect to residential loans that are secured by 1-4 family residences and are generally owner occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences. Repayment on residential loans can be impacted by changes in property values on residential properties. Consumer loans are secured by consumer assets such as automobiles, horse trailers, or recreational vehicles. Some consumer loans are unsecured, such as small installment loans and certain lines of credit. Repayment of consumer loans is primarily dependent upon the personal income of the borrowers, which can be impacted by economic conditions in their market areas such as unemployment levels. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

Allowance for Loan Losses Methodology

Company policy is designed to ensure that an adequate allowance for loan losses (“ALLL”) is maintained. The portfolio is segmented by loan type. The required ALLL for types of performing homogeneous loans which do not have a specific reserve is determined by applying a factor based on historical losses averaged over the past twelve months. Management believes the historical loss experience methodology is appropriate in the current economic environment, as it captures loss rates that are comparable to the current period being analyzed. Management adds qualitative factors for observable trends, changes in internal practices, changes in delinquencies and impairments, and external factors. Observable factors include changes in the composition and size of portfolios, as well as loan terms or concentration levels. The Company evaluates the impact of internal changes such as management and staff experience levels or modification to loan review processes. Delinquency trends are scrutinized for both volume and severity of past due, nonaccrual, classified or graded loans as well as any changes in the value of underlying collateral. Finally, the Company considers the effect of other external factors such as national, regional and local economic and business conditions, as well as competitive, legal and regulatory requirements. All criticized, classified, and impaired loans are evaluated for impairment by applying at least one of three methodologies: present value of future cash flows; fair value of collateral less cost to sell; or the loan’s observable market price. All troubled debt restructurings (“TDR”) are considered impaired loans. Loans evaluated for impairment are removed from other pools to prevent double-counting.

Provision for Loan Losses

A provision for estimated losses on loans is charged to operations based upon management’s evaluation of the potential losses. Such an evaluation, which includes a review of all loans for which full collectability may not be reasonably assured considers, among other matters, the estimated net realizable value of the underlying collateral, as applicable, economic conditions, loan loss experience, and other factors that are particularly susceptible to changes that could result in a material adjustment in the near term. While management endeavors to use the best information available in making its evaluations, future allowance adjustments may be necessary if economic conditions change substantially from the assumptions used in making the evaluations.

Accounting Standards Codification (“ASC”) Topic 310, Receivables, requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loans’ effective interest rates or the fair value of the underlying collateral and allows existing methods for recognizing interest income.

Policy for Charging Off Loans

The Company’s policy is to charge off a loan at any point in time when it no longer can be considered a bankable asset, meaning collectible within the parameters of policy. A secured loan is generally charged off to the estimated fair value of the collateral, less costs to sell, no later than when it is 120 days past due as to principal or interest. An unsecured loan generally is charged off no later than when it is 180 days past due as to principal or interest. All charge-offs are approved by the Chief Credit Officer.

The following tables present changes in the balance of the ALLL during the three month periods ended March 31, 2014 and 2013:



	Three Months Ended March 31, 2014
	Residential Real Estate			Commercial Real Estate		Commercial		Consumer			Total
Allowance for loan losses:
Balance, beginning of period	$	1,219		$	2,517	$	819	$	871		$	5,426
Provision (credit) charged to expense	(66		)	179		52		(18		)	147
Losses charged off	(122		)	—		—		(169		)	(291		)
Recoveries	13			—		—		93			106
Balance, end of period	$	1,044		$	2,696	$	871	$	777		$	5,388



	Three Months Ended March 31, 2013
	Residential Real Estate			Commercial Real Estate			Commercial		Consumer			Total
Allowance for loan losses:
Balance, beginning of period	$	1,149		$	3,107		$	371	$	1,206		$	5,833
Provision (credit) charged to expense	(81		)	(25		)	95		145			134
Losses charged off	(54		)	—			—		(236		)	(290		)
Recoveries	8			—			—		63			71
Balance, end of period	$	1,022		$	3,082		$	466	$	1,178		$	5,748

The following tables present the recorded investment in loans based on portfolio segment and impairment method as of March 31, 2014, and December 31, 2013:



	March 31, 2014
	Residential Real Estate		Commercial Real Estate		Commercial		Consumer		Total
Loans:
Ending balance	$	192,733	$	166,800	$	63,373	$	104,694	$	527,600
Ending balance: individually evaluated for impairment	1,181		1,051		—		325		2,557
Ending balance: collectively evaluated for impairment	$	191,552	$	165,749	$	63,373	$	104,369	$	525,043
Allowance for loan losses:
Ending Balance	$	1,044	$	2,696	$	871	$	777	$	5,388
Ending balance: individually evaluated for impairment	9		—		—		16		25
Ending balance: collectively evaluated for impairment	$	1,035	$	2,696	$	871	$	761	$	5,363



	December 31, 2013
	Residential Real Estate		Commercial Real Estate		Commercial		Consumer		Total
Loans:
Ending balance	$	191,007	$	142,429	$	55,168	$	107,562	$	496,166
Ending balance: individually evaluated for impairment	1,684		1,054		—		339		3,077
Ending balance: collectively evaluated for impairment	$	189,323	$	141,375	$	55,168	$	107,223	$	493,089
Allowance for loan losses:
Ending Balance	$	1,219	$	2,517	$	819	$	871	$	5,426
Ending balance: individually evaluated for impairment	116		98		—		28		242
Ending balance: collectively evaluated for impairment	$	1,103	$	2,419	$	819	$	843	$	5,184

The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 8. A description of the general characteristics of the eight risk grades is as follows:

•

Grades 1 & 2 - These grades are assigned to loans with very high credit quality borrowers of investment or near investment grade or where the loan is primarily secured by cash or conservatively margined high quality marketable securities. These borrowers are generally publicly traded, have significant capital strength, possess investment grade public debt ratings, demonstrate low leverage, exhibit stable earnings and growth and have ready access to various financing alternatives.

•

Grades 3 & 4 - Loans assigned these grades include loans to borrowers possessing solid credit quality with acceptable risk. Borrowers in these grades are differentiated from higher grades on the basis of size (capital and/or revenue), leverage, asset quality, stability of the industry or specific market area and quality/coverage of collateral. These borrowers generally have a history of consistent earnings and reasonable leverage.


•	Grade 5 - This grade includes “Pass Grade” loans to borrowers which require special monitoring because of deteriorating financial results, declining credit ratings, decreasing cash flow, increasing leverage, marginal collateral coverage or industry stress that has resulted or may result in a changing overall risk profile.


•	Grade 6 - This grade is for “Special Mention” loans in accordance with regulatory guidelines. This grade is intended to include loans to borrowers whose credit quality has clearly deteriorated and where risk of further decline is possible unless active measures are taken to correct the situation. Weaknesses are considered potential at this state and are not yet fully defined.

•

Grade 7 - This grade includes “Substandard” loans in accordance with regulatory guidelines. Loans categorized in this grade possess a well-defined credit weakness, and the likelihood of repayment from the primary source is uncertain. Significant financial deterioration has occurred, and very close attention is warranted to ensure the full repayment without loss. Collateral coverage may be marginal, and the accrual of interest has been suspended.

•

Grade 8 - This grade includes “Doubtful” loans in accordance with regulatory guidelines. Such loans have been placed on nonaccrual status and may be heavily dependent upon collateral possessing a value that is difficult to determine or based upon some near-term event which lacks clear certainty. These loans have all of the weaknesses of those classified as Substandard; however, based on existing conditions, these weaknesses make full collection of the principal balance highly improbable.

Nonaccrual Loans

Any loan which becomes 90 days delinquent or has the full collection of principal and interest in doubt will be considered for nonaccrual status. At the time a loan is placed on nonaccrual, all accrued but unpaid interest will be reversed from interest income. Placing the loan on nonaccrual does not relieve the borrower of the obligation to repay interest. A loan placed on nonaccrual may be restored to accrual status when all delinquent principal and interest has been brought current, and the Company expects full payment of the remaining contractual principal and interest.

The following tables present the credit risk profile of the Company’s loan portfolio based on rating category and payment activity as of March 31, 2014 and December 31, 2013:



	March 31, 2014
	Commercial Real Estate		Commercial
Rating:
1-5 Pass	$	163,445	$	62,617
6 Special Mention	2,304		756
7 Substandard	1,051		—
8 Doubtful	—		—
Total	$	166,800	$	63,373



	March 31, 2014
	Residential Real Estate		Consumer
Performing	$	192,596	$	104,553
Nonaccrual	137		141
Total	$	192,733	$	104,694



	December 31, 2013
	Commercial Real Estate		Commercial
Rating:
1-5 Pass	$	139,052	$	54,035
6 Special Mention	2,323		1,133
7 Substandard	1,054		—
8 Doubtful	—		—
Total	$	142,429	$	55,168



	December 31, 2013
	Residential Real Estate		Consumer
Performing	$	190,377	$	107,412
Nonaccrual	630		150
Total	$	191,007	$	107,562

The following tables present the Company’s loan portfolio aging analysis as of March 31, 2014 and December 31, 2013:



	March 31, 2014
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable		Non- accrual Loans		Total Loans 90 Days or More Past Due and Accruing
Residential real estate	$	74	$	27	$	111	$	212	$	192,521	$	192,733	$	137	$	—
Commercial real estate	—		—		955		955		165,845		166,800		1,051		—
Commercial	—		—		—		—		63,373		63,373		—		—
Consumer	224		34		87		345		104,349		104,694		141		23
Total	$	298	$	61	$	1,153	$	1,512	$	526,088	$	527,600	$	1,329	$	23



	December 31, 2013
	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans Receivable		Non- accrual Loans		Total Loans 90 Days or More Past Due and Accruing
Residential real estate	$	122	$	—	$	603	$	725	$	190,282	$	191,007	$	630	$	—
Commercial real estate	—		—		955		955		141,474		142,429		1,054		—
Commercial	—		—		—		—		55,168		55,168		—		—
Consumer	484		45		84		613		106,949		107,562		150		18
Total	$	606	$	45	$	1,642	$	2,293	$	493,873	$	496,166	$	1,834	$	18

Impaired Loans

A loan is designated as impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16) when, based on current information or events, it is probable that the Company will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Payments with insignificant delays not exceeding 90 days outstanding are not considered impaired. Certain nonaccrual and substantially all delinquent loans may be considered to be impaired. Generally, loans are placed on nonaccrual status at 90 days past due and accrued interest is reversed against earnings, unless the loan is well-secured and in the process of collection. The accrual of interest on impaired and nonaccrual loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due.

Impaired loans include nonperforming commercial loans but also include loans modified in TDRs where concessions have been granted to borrowers experiencing financial difficulties. These concessions could include a reduction in the interest rate on the loan, payment extensions, forgiveness of principal, forbearance or other actions intended to maximize collection.

The following table presents the Company’s impaired loans as of March 31, 2014 and December 31, 2013:



	March 31, 2014						December 31, 2013
	Recorded Balance		Unpaid Principal Balance		Specific Allowance		Recorded Balance		Unpaid Principal Balance		Specific Allowance
Loans without a specific valuation allowance
Residential real estate loans	$	1,155	$	1,186	$	—	$	1,551	$	1,842	$	—
Commercial real estate loans	1,051		1,509		—		956		2,310		—
Commercial loans	—		—		—		—		—		—
Consumer loans	269		457		—		271		326		—
Total	2,475		3,152		—		2,778		4,478		—
Loans with a specific valuation allowance
Residential real estate loans	26		34		9		133		141		116
Commercial real estate loans	—		—		—		98		98		98
Commercial loans	—		—		—		—		—		—
Consumer loans	56		100		16		68		80		28
Total	82		134		25		299		319		242
Total impaired loans
Residential real estate loans	1,181		1,220		9		1,684		1,983		116
Commercial real estate loans	1,051		1,509		—		1,054		2,408		98
Commercial loans	—		—		—		—		—		—
Consumer loans	325		557		16		339		406		28
Total	$	2,557	$	3,286	$	25	$	3,077	$	4,797	$	242

The table below presents average balances and interest income recognized for impaired loans during both the three month periods ended March 31, 2014 and March 31, 2013:



	Three Months Ended
	March 31, 2014				March 31, 2013
	Average Balance		Interest Income		Average Balance		Interest Income
Loans without a specific valuation allowance
Residential real estate loans	$	1,162	$	7	$	2,145	$	7
Commercial real estate loans	1,052		—		—		—
Commercial loans	—		—		—		—
Consumer loans	296		4		365		—
Total	2,510		11		2,510		7
Loans with a specific valuation allowance
Residential real estate loans	26		—		232		—
Commercial real estate loans	—		—		2,466		1
Commercial loans	—		—		—		—
Consumer loans	78		—		110		—
Total	104		—		2,808		1
Total impaired loans
Residential real estate loans	1,188		7		2,377		7
Commercial real estate loans	1,052		—		2,466		1
Commercial loans	—		—		—		—
Consumer loans	374		4		475		—
Total	$	2,614	$	11	$	5,318	$	8

Troubled Debt Restructurings (“TDRs”)

The loan portfolio includes TDRs which are loans that have been modified to grant economic concessions to borrowers who have experienced financial difficulties. These concessions typically result from loss mitigation efforts and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructuring and typically are returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally not less than six months.

When loans are modified in a TDR, any possible impairment similar to other impaired loans is evaluated based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, or using the current fair value of the collateral, less selling costs for collateral dependent loans. If it is determined that the value of the modified loan is less than the recorded balance of the loan, impairment is recognized through a specific allowance or charge-off to the allowance. In periods subsequent to modification, all TDRs, including those that have payment defaults, are evaluated for possible impairment, and impairment is recognized through the allowance.

In the course of working with troubled borrowers, the Company may choose to restructure the contractual terms of certain loans in an effort to work out an alternative payment schedule with the borrower in order to optimize the collectability of the loan. Any loan modified is reviewed by the Company to identify if a TDR has occurred (when the Company grants a concession to the borrower that it would not otherwise consider based on economic or legal reasons related to a borrower’s financial difficulties). Terms may be modified to fit the ability of the borrower to repay in line with its current financial status or the loan may be restructured to secure additional collateral and/or guarantees to support the debt, or a combination of the two.

Loans classified as TDRs during the three months ended March 31, 2014 and 2013 are shown in the tables below. The 2014 and 2013 modifications consisted solely of maturity date concessions.



	New TDRs During the Three Months Ended
	March 31, 2014					March 31, 2013
	Number of Contracts	Recorded Balance Before		Recorded Balance After		Number of Contracts	Recorded Balance Before		Recorded Balance After
Real estate loans:
Residential	—	$	—	$	—	—	$	—	$	—
Commercial	—	—		—		—	—		—
Total real estate loans	—	—		—		—	—		—
Commercial loans	—	—		—		—	—		—
Consumer loans	1	21		21		2	2		2
Total loans	1	$	21	$	21	2	$	2	$	2

There were no TDR loans which had payment defaults during the three months ended March 31, 2014 and 2013. Default occurs when a loan is 90 days or more past due or transferred to nonaccrual within twelve months of restructuring.